It's Not About the Doughnuts

Can an old New England pastry purveyor find new life as a hip coffee shop? Dunkin' Donuts plans to give Starbucks a run for its latte.

The Strategy: Time to Ditch the Donuts

I'm standing in line at the counter of a Dunkin' Donuts shop at the corner of Murray and Church in Manhattan's gritty-but-chic Tribeca. It's 5 p.m, the downtown hipster's low blood sugar hour. I have a stop watch in my hand. Stepping to the counter behind a dude in pocket chains and dagger-toed boots, I announce my order: "One small skim vanilla latte, please" to the young clerk, and start the clock. The espresso machine hisses, the milk starts foaming, the counter boy hands over the goods. 2 minutes, 4 seconds, $2.16.

I travel a few blocks down the street to Starbucks at the corner of West Broadway and Chambers. I repeat the order to the register-manning barrista, making sure I specify "tall," which means "small" in the convoluted vernacular of the chain, hit the clock, and wait. The result: 2 minutes, 55 seconds, $3.69.

Digging deep into my lizard brain for traces of what I learned about the scientific method back in Chem 101, I repeat this exercise twice, each time matching location for location, order for order, time of day for time of day. You can check my T&E for proof.

The result: Dunkin' Donuts is the clear champ, taking less time to brew and froth, and doing it for about 40% less than Starbucks (an amount that overstates the difference between them a bit, given Starbucks's larger cup). So, what's the point?

If you're going to take on Starbucks, the leviathan of the coffee business, you need an edge. And Dunkin' Donuts, the 54-year-old New England chain famous for its Boston Crème doughnuts and award-winning beans, thinks it's found the key to being a contender: speed and price. So this, then, is the new management team's new strategy: be the faster, cheaper, user-friendlier alternative to Starbucks -- the average Joe's average joe.

Sounds logical, right? No silly faux Italian. No lattes that require an Amex mogul card. Just value and speed. But Dunkin's strategy is already raising concerns among some industry observers. The idea that the latte-drinking customer will respond to speed and price is, they say, an out-moded view of the market. Sure, it worked for McDonald's, a pit stop for customers with little time, many kids, and thin wallets. But for trendy coffee aficionados, those features may be missing the point.

"Espresso drinking is part of a lifestyle," says Joseph Pawlak, senior principal at restaurant industry trend tracking firm Technomic. "Many of those customers are looking for atmosphere, for a place to hang out, for velvet sofas. Dunkin' will need to address that in the longer term."

Indeed, many would argue that Howard Schultz's true stroke of genius was understanding just that: modern brand-building is at least as much about the customer experience as it is about the actual product. As Schultz told Fast Company last July, "We've known for a long time now that Starbucks is more than just a wonderful cup of coffee. It's the experience."

Dunkin' Brands CEO Jon Luther and his team, however, are convinced that there's a market to be tapped, especially among a younger audience that is enamored of Starbucks' frothy beverage menu, but daunted by the Seattle chain's budget-busting prices. The first move in their assault: to install super-speedy $10,000 Ambiente espresso machines in prime locations, capable of delivering a tony coffee drink in 44 seconds. The second: to design a menu that will encourage that beverage drinker to buy a little nosh to go with his drink -- a bagel, a muffin, a breakfast sandwich, or even -- yikes! -- a doughnut in the morning, and a little snack in the afternoon.

That, says marketing vice president John Gilbert, is the company's C+1 strategy (coffee plus something else): get 'em in, sell 'em coffee and a snack, and get 'em out. Leave the fancy CD-burning stations, moody lighting, and comfy chairs to the competition. "We won't have wi-fi and couches and fireplaces," he says, "We'll have speed, speed, speed."

Already, 57% of the chain's sales -- and the most profitable product group -- are beverages, with the rest made up largely of bagels, muffins, and breakfast sandwiches. Starbucks, by comparison, does 78% of its store volume in beverages, with 12% in food, and 5% in whole beans. With the espresso-based drink market showing a 68% increase since 2000, it would appear to be an area with wide open possibilities for several players.

But where does that leave the company's signature product, not to mention the lovable schlub who for years appeared in Dunkin's ads blearily muttering "Time to make the donuts!" History, my friends, a victim of two juggernaut trends: the yuppification of coffee and the vilification of donuts and their high-carb brethren. Sketching on a slip of paper, Luther doesn't even include Krispy Kreme in the map of his competitive set. "We touch Starbucks, we touch McDonald's, we touch Tim Horton's, we touch convenience stores," he says, drawing a series of rings around a big circle labeled "DD". "Krispy Kreme is over here," he says, penciling a little ring outside the orbit, "because they're not really in the coffee business. They're 98% donuts, and 82% glazed, so they're a one trick pony."

Luther didn't need the bankruptcy of Interstate (the venerable bakery behind such American pastry icons as Twinkies and Wonder Bread) to see the writing on the oven door. Buffeted by the public's phobia of baked goods, and their embrace of over-the-top beverages (white chocolate raspberry mocha latte, anyone?), Luther and his team, a troop of fellow-travelers from his days at Popeye's Chicken and Biscuits, determined that the future was not in the cruller, but in the coffee.

"We're marching to a real evolution in our menu," chimes in Joseph Scafido, chief menu officer, at a meeting at the company's headquarters in suburban Boston. "We're taking what has been a doughnut bakery-centric concept to a beverage-centric concept. That, we think will be our long term competitive advantage."

The Challenge: The Battle of the Beans

But Dunkin' faces more challenges than simply brainstorming fancy drinks and devising little treats to go with them. While many of the chain's suburban New England shops are clean and shiny, albeit bereft of any upholstered furniture, a fair number in more urban locations are -- how can we say this diplomatically? Down right scuzzy. In the late afternoon, when the bins are empty but for a few dispirited doughnuts, and the fluorescent light is harsh against the winter night, they're hardly an appealing beacon to a customer searching for a soothing place to re-energize. They make a veritable mockery of the company's new mission statement: "Rituals that revive." Those locations are less about a pleasant ritual, which speaks to the idea of self-nurturing, than about the urgent need for revival: coffee as a cheap fatigue-fighting drug, to be gulped while rushing to your second shift job.

That may be a problem going forward, says Udo Schlentrich, Director of the William Rosenberg International Center of Franchising at the University of New Hampshire. "When you look at Dunkin's store sales beyond the peak hours of drive-to work, drive-from work, you have this incredible void," he says. "How do you bring people in for a little break? Starbucks is already in more locations, and it has the feeling and décor of a hang-out place. Dunkin' is a hit-and-run place."

A recent analysis of the two chains by Smith Barney's restaurant group expressed reservations that the introduction of the espresso-based coffee line alone would make much of a long-term difference in the chain's revenues. The report scrutinizes the Quick Serve Restaurant (QSR) business of the British liquor giant Allied Domecq PLC, which is the parent company of Dunkin' Donuts, and its sister restaurants Baskin Robbins and Togo's. Looking at sector's first half fiscal 2004 results, they reported, "The division's profits did get a strong uplift from the introduction of new products (the new coffee range)... but since this is a one-off step, we would not expect the QSR business to be anywhere close to the first half's strong growth rate. Going forward, we expect sales growth of 6% (same store and new store combined.)"Dunkin' Donuts had sales of $3.4B in fiscal year 2004.

Give us some time, the Donuts guys say; lattes are only the beginning.Taking a look at data that indicates that Americans have become a nation of snackers, not meal-eaters, Dunkin's menu gurus are currently brainstorming an array of little treats -- some sweet, some savory -- that could satisfy that fitful craving, and add additional 'day parts' to the chain's traffic. They point to the explosion of tapas menus in the trend-setting precincts of the restaurant business, and the vast appetizer menus now appearing at such national chains such as Houlihan's and The Cheesecake Factory, as proof that the concept has legs.

"Most of the (quick serve restaurant) industry got caught up in the idea of home meal replacement, thinking people eat three meals at home" says Gilbert. "But the consumer has jumped. They're looking for five snacks a day instead." The average lunch hour, he says, is now a pathetic 19 minutes -- just time enough to run to the corner, grab a bagel, and get back to your computer (much to the chagrin of the IT folks charged with cleaning up gunky keyboards).

For his part, Luther is undaunted by the challenge he faces. Indeed, he sounds a little like Howard Dean on the night of the Iowa primaries when he talks about moving beyond the chain's parochial base in New England to conquer America's heartland: "I tell everybody we're crossing the Hudson, we're crossing the Delaware, we're crossing the Potomac, and someday we're going to cross the Mississippi!" he declaims, stopping just short of a whoop.

Right now, he points out, Dunkin' is already selling 2.8 million cups of coffee a day, or 16% of all coffee sold by the cup in the U.S. And they've only begun to fight. Currently the chain is opening about 700 shops a year, in places like Charlotte, Cleveland, Detroit, Tampa, and Cinncinnati. They'll expand that to 800-1000 a year, he says. It's a game that relies on ubiquity. "You don't go 20 miles out of your way to have a cup of coffee," he says. Currently, Dunkin' has 1,644 shops in New England, or one for every 7200 people. Starbucks has 203. "We're not going to be able to replicate that, " Luther says, " but I think one to every 15,000 to 20,000 people [in target markets] is probably a good goal." (Worldwide, Starbucks has more than 4,700 retail stores and 2,800 licensed units, versus Dunkin's 6,000.)

That ambitious roll-out plan may run up against some trouble when it comes time to find the requisite real estate, says Pawlak. "If you're thinking about gourmet coffee, you want to go into areas that are more white collar and affluent," he says. "The A and B sites are basically gone, so your choice is to settle for a C site or buy an A site that's very expensive." Luther says he's concerned, but not daunted by the situation, since the high margins in the coffee business will allow him to snag good sites. "We are not finding real estate to be our major issue," he says.

The Future: A Billion Cups and Counting

Liz Barnett is a Dunkin' Donuts executives' dream girl. The 18-year-old freshman at Roger Williams College has taken her Manhattan-spawned addiction to the chain's French vanilla coffee ("large, light and sweet") with her to school in Rhode Island, the very epicenter of Dunkin's fiefdom. Within a few blocks, Barnett can sample the wares of six different Dunkin' Donuts shops, an opportunity she hasn't let pass her by.

Plus, she's a peer influencer, helping to hook that precious 18 to 24 year old demographic that Luther covets. On a recent trip back to her high school in New York, she discovered her Dunkin' dedication had lived on as a sort of class legacy: "My friends there said, 'We all drink Dunkin' Donuts because of you!"

While she had half a dozen Starbucks within a short stroll of her home on New York's Upper East Side, she said she gravitated to a hole-in-the-wall Dunkin' on E. 86th St. because of the coffee's less bitter taste. Now, as a price-sensitive student, she's also attracted by its price. "Dunkin' Donuts is economically beneficial to me," she says. "I don't want to get a $5 cup of coffee if I can get a $1 cup of coffee."

Still, she's a little annoyed that the chain's quality varies so much from shop to shop - from the watery brew at the restaurant near school, to the "horrible" service at the one near the gas station. She recognizes that this a problem that affects many franchise operations, including McDonald's, but, she says, "I notice it much more in Dunkin' Donuts than anywhere else."

For his part, Luther knows he has a problem. When he took over in 2003, one of his first acts was to embark on a road show to meet his 2700 franchisees. His message to them:"We're changing this game, we're raising the stakes, if you don't like it, get out. We'll buy your store." He also took a number of franchisees to court over lax standards, and won nearly every case. Things have calmed down considerably since that litigious interlude, but Luther is resigned about his ability to deliver the customer experience he'd like.

"Everybody says it's about the crew members," he says. "But not only can you not get them to up-sell, you can't even get them to smile and say thank you! Half the time you've got an 18-year-old kid who's looking at his watch, or an immigrant who's not speaking the language as well as you want." Luther's solution? To help the customer feel the love based on the quality of the product, not the transcendent experience. "We'll keep the place clean, you'll get it fast, it will be portable, and the quality will be there. That will be the ritual that we meet."

Freed from the notion then, of having to compete on Starbucks's terms, Luther can set his sights on expanding to locations where speed, price, and quality are the relevant metrics: alternative venues --- kiosks and drive-thrus in airports, carts in ski resorts, counters in supermarkets. And, perhaps the biggest possible deal, a partnership with Wal-Mart, which is still in the testing phase, but going well.

"Five years from now, if you're looking for coffee," Luther says, "there will be only two places you'll be thinking about: Starbucks and Dunkin'. We don't want to replace them -- my God, they're terrific. All I want is a little piece of the pie: A billion cups a year," he says, exploding into gales of laughter.

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